Has the solar-power industry lapsed into a classic cycle of boom and bust after a decade of unprecedented growth? It might appear so. As years of government subsidies boosted the global installed capacity of solar-photovoltaic (PV) modules and dramatically cut prices, new producers, including China, rushed into the market, prompting oversupply and pressure on margins that threaten many pioneering players. Demand today isn’t keeping up with supply, and governments continue to scale back support as they cope with the aftermath of the economic crisis.

Despite the challenges, new McKinsey research indicates that the industry is suffering from growing pains rather than undergoing death throes. Solar is entering a period of maturation that, in just a few years, will probably lead to more stable and expansive growth for companies that can manage costs and innovate to tap rising demand from multiple customer segments.

“Solar power: Darkest before dawn” finds that underlying PV costs are likely to continue to drop as manufacturing capacity doubles over the next three to five years. Indeed, the cost of a typical commercial system could fall 40 percent by 2015 and an additional 30 percent by 2020, permitting companies to capture attractive margins while vigorously installing new capacity.

The research suggests that the overall solar market will continue to grow—even though subsidies are expected to dry up. This growth, over the next 20 years, will stem largely from demand based on viable stand-alone economics in five customer segments: off-grid, residential and commercial in areas with good and moderate sun conditions, isolated grids, peak capacity in growth markets, and new large-scale power plants (exhibit).

To succeed in this environment, companies should direct their attention to the relatively prosaic objective of reducing costs, without giving up on the imperative to innovate, which has been critical to success thus far. Many companies can cut their costs dramatically by adopting approaches widely used in more mature industries to optimize areas such as procurement, supply chain management, and manufacturing—and therefore position themselves to capture attractive margins even as prices for PV modules fall.

Exhibit

Solar power is approaching a tipping point in a number of customer segments.